Why restaurant companies don't opt for going public

Pre-pandemic was a big time for restaurant IPOs. While many companies like Barbeque Nation and Speciality Restaurants went public and several more were reportedly planning to do so. 2022 has been a different story. Restaurant IPO activity has gone silent amid a turbulent stock market. But there are other underlying trends that should help create a more favourable environment for IPOs once things settle down.

The one thing that IPOs need is a stable environment. And global financial markets have not been very stable lately. Inflation, rising interest rates and geopolitical tensions resulted in a fairly broad market reset in the fourth quarter of 2021 with markets down 10 percent to 15 percent overall. 

Wild market swings make it difficult for companies to set an IPO price, which is determined relative to other stocks’ prices. Restaurant companies planning to go public are likely waiting out the choppiness before diving in. 

The lower demand pushed down the prices these restaurant companies could fetch in an IPO, making it less desirable for companies to raise funds this way. In addition, overall weakness in the restaurant industry pushed down stock prices, which also made an offering less desirable. Investment bankers have long argued that any company if it’s good enough, can go public at any time.

But if these good companies can attract higher valuations by selling to private-equity firms or other private investors, then they almost certainly will go that route. What’s the point of going through the cost and hassles of an IPO if you’re not getting a premium valuation?

“I think that restaurants usually don't switch to IPOs because of a limited turnover. It's still feasible for a very big chain of restaurants. But looking at the current scenario there have been a lot of difficulties faced by the restaurant industry. Having IPOs, in that case, might incur risky bait for the restaurateurs and employees as well. In fact, many international chains of restaurants have faced a huge risk post covid due to IPO allocation which makes us think twice before switching to IPOs,” Debaditya Chaudhury, managing director of Chowman, Oudh 1590 & Chapter 2 commented.

Indeed, some companies long thought of as IPO candidates have instead taken private-equity investors. What’s more, companies with weak sales are less likely to go public. So, the two year weakness has likely filtered out some of the companies that might have gone public.

One of the biggest IPO failures of the food service industry was Zomato in 2021. It is clear that the startup is incurring significant losses. Zomato’s ambitious expansion plans have caused a serious dent in its financial performance (and will continue to do so). It has to pump crores into advertising and promotional activities to drive customer growth. They incur huge customer acquisition costs by offering frequent discounts and referral bonuses. On 15th February 2022, for the first time since its market debut, Zomato shares dropped below their issue price.

Investor wealth has plummeted with the recent sell-off in new age tech stocks. The reasons for the decline are earnings disappointments, high valuations, and growing fears of aggressive monetary tightening to curb soaring inflation.

While IPOs are a great way to fundraise and generate publicity and credibility in the market, they come with heavy expectations. According to Supreet Raju, co-founder, OneRare, an IPO carries an excellent financial burden for the business, and in an industry as dynamic as food, this can quickly become problematic. 

“Food businesses operate on thin margins and results for each quarter can vary on food inflation and market dynamics. For restaurant founders, an IPO can bring great external pressure to their business, which can be unsavoury. Restaurants require quick decisions, and creative overhauls and IPOs can sometimes lead to a loss of control. Any restaurant wanting an IPO would have to be sure-footed before opening its business up for public scrutiny,” Raju further explained.

To understand how dramatically the companies’ fortunes changed, one has to go back to that era, in which investors were bidding ridiculous prices for growth chains. The enthusiasm for these companies was such that many large private-equity firms were investing in upstart concepts in a bid to find their own gold mine. Some entrepreneurs with no industry experience were jumping into the business, sensing an opportunity to latch onto the fast-casual boom.

Back in 2012, The Specialty Restaurants Ltd. initial public offering was a landmark event for more than one reason. It was the first Indian restaurant company to go public. (Jubilant Foodworks, another listed entity, is a franchisee for Domino’s Pizza and Dunkin’ Donuts.) Secondly, the relatively modest 34 million US dollars IPO, oversubscribed 2.5 times, gave private equity investors a rare exit. The other reason the Specialty listing is important is that it has made the restaurant sector India’s new private equity darling, threatening to replace IT ITES (information technology information technology enabled services). But the situation looks bleak after 10 years.

Now the problem with such offerings is that the younger a restaurant chain is, the riskier the investment. Growth chains run into problems, especially as they test new markets and expand beyond core areas. Many companies simply don’t do well as larger chains, but there is intense pressure on small chains to add units, even to their own detriment.

What’s the result of all this? Well, chains that might have gone public were instead sold to other private-equity firms, just like what happened before the IPO boom. Institutional investors simply have no appetite for the risk that small companies present. While they would welcome a strong chain to the public markets.

With interest rates low, investors are gobbling up equities. Private equity firms, which tend to buy up restaurants in bundles, are looking to cash out by taking the companies public. While the demand for restaurants is hot right now, analysts say this is cyclical. It’s almost like rushing for the gates because all it takes is one that goes particularly sideways and then it could close right back up.